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Bitcoin, the virtual currency that has no ties to any government, has become important enough to turn into a political issue. On Wednesday, the government of Israel – including nearly all agencies that have anything to do with money – published a warning against Bitcoin use.

In a joint statement, the Bank of Israel, the Israel Tax Authority, the Israel Securities Authority, and the Justice Ministry’s Money Laundering and Terror Financing Prohibition Authority said that using virtual currency in general, and Bitcoin in particular, was a very bad idea, because it was unsupervised, and as a result provided hucksters with great opportunity for fraud, theft, debt evasion, and criminal activity like money laundering.

Created and produced completely independent of any central bank, Bitcoins are the best-known example of a growing number of virtual currencies that are currently traded like commodities – and are increasingly being accepted as “legal tender” by Internet retailers.

Recently, two large American online retailers – Overstock.com and TigerDirect.com – announced they would accept Bitcoins for some transactions, and a site called eGifter.com allows customers to use Bitcoins to buy gift certificates to over 150 retailers, including Old Navy, Barnes and Noble, American Eagle, CVS, Domino’s Pizza, and many others. Using an online platform called Coinbase, eGifter says on its site, users can buy any of its gift certificates anonymously and securely, transferring the purchased gift certificate to their smartphone and using it in-store.

Israeli authorities are not convinced, though. In the statement, the agencies emphasized that Bitcoin is not legal tender, and as such those who suffered losses by using it should not count on any help from law enforcement authorities.

The statement represents the first official comment on the Bitcoin phenomenon by the Israeli government. The agencies did not ban the use of Bitcoin or other virtual currencies, but advised Israelis “to be aware of the features of virtual currency, including the risks involved in using them, and to be observant and cautious. With this statement, Israeli authorities are joining those in the US, Canada, the European Union, and others who have issued similar warnings,” the statement said.

Among the chief dangers for Israel, according to the statement, is that virtual currency could be used by terrorists. “Virtual currencies allow for the anonymous transfer of money, often in manners that violate money-laundering laws, and with a strong possibility that the currency will be used to finance terror. Financial institutions should be aware of these possibilities when forming policy, and take into account the requirements to inform authorities in cases where money laundering or terror financing is suspected.”

Bitcoin also makes it easier for fraudsters to rip off ordinary people, the statement said. The fact that Bitcoin is a new high-tech way of using money gets people’s attention, and they may ignore the possibility that an investment scheme being presented involving Bitcoin or other virtual currencies may not be 100% “kosher.” The Bitcoin marketplace, in fact, is a good example of that, said the statement. “Virtual currencies like Bitcoin are subject to significant price swings.” Whatever goes up must go down, the statement said – and investors should not count on the price of Bitcoins remaining high forever.

At least some of the concerns expressed by Israeli officials were validated several weeks ago, when Mt. Gox, the world’s first Bitcoin trading exchange, announced that it had shut down operations because it had been hacked (Mt. Gox handles about 25% of the world’s Bitcoin transactions; other sites were not affected by the hack). It was not the first time the site had been hacked, either; account holders at Mt. Gox lost nearly $9 million in June 2011 due to a hack. The recent hack had a dramatic effect on the virtual currency’s value; after reaching a high of $1,124, Bitcoins are now trading in the area of $670 each.

But security issues can be resolved, Bitcoin enthusiasts say, and overall there are lots more plusses than minuses to virtual currency use. In a blog post (written after the Mt. Gox hack) Roger Wu, owner of an online sales site, said that Bitcoin was “less risky than any currency. Since Bitcoin is not tied to any country, the currency is theoretically more stable and suffers from less political risk.” In addition, it was more secure than credit cards or cash. The former can be hacked (a huge breach last month on US retailer Target’s servers netted millions of credit card numbers for hackers, said Wu), while the latter can be lost. Not to mention the other benefits, such as lower transaction costs and easier international transactions, he added.

Jonathan Rouach (Photo credit: Courtesy)

The worst part of the statement, said Jonathan Rouach, an entrepreneur who is deeply involved in the Israeli Bitcoin world, was the failure of authorities to acknowledge the Israeli Bitcoin community’s efforts to abide by the law. “We are law-abiding people who cooperate with police or other authorities when called upon to do so,” said Rouach, CEO of Bits Of Gold, a Bitcoin-trading platform. “If you look at the biographies of the people who do business with my site and the other Israeli virtual-currency sites, you will see that our customers are not mafia-style ‘legitimate businessmen’ or terrorists, but truly legitimate members of the financial and technology communities who are excited about virtual currency as the future of money.”

Rouach does not deny the risks listed in the statement; to the contrary. “The Israel Bitcoin Association, which I and other entrepreneurs belong to, acknowledge these risks, and tells people not to invest in Bitcoins unless they are able to take a potential loss.” However, he points out, all the risks involved in Bitcoin use are just as valid for cash or credit cards, if not more so.

“In fact, if anyone is to blame for the situation, it is the authorities themselves,” said Rouach. “I, along with many other entrepreneurs in Israel, have been after the Bank of Israel for months to issue regulations on Bitcoin use.” The statement does not institute any rules, so it does not constitute regulation – but despite the fact that it puts Bitcoins in a negative light, Rouach is happy that it was issued at all. “At least they now acknowledge that there is such a thing as Bitcoin.”

The alarmist tone of the statement notwithstanding, it may have just the opposite effect – driving Israelis towards Bitcoin, instead of away from it, said Rouach. Police, the statement said, could – and would – close down trading platform’s like Rouach’s and seize assets if illicit activity is suspected. “Law enforcement authorities are therefore likely to close trading platforms in virtual currencies which are used for illegitimate activities, by preventing access or use of customers’ capital, which would likely be held by those platforms,” said the officials.

That threat, said Rouach, could very well boomerang. “Here they are trying to scare off Bitcoin users by saying that their accounts could be seized, but since Bitcoin is virtual – and the servers that handle transactions can be easily backed up or replicated – the accounts will continue to function,” said Rouach. “While the authorities can stop transactions in banks, they can’t stop Bitcoin transactions, and that’s a powerful motivation for users to adopt virtual currencies, and throwing out such threats is only going to convince more people to consider using Bitcoins.”

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